India bond yields surge in four months as RBI drains cash

INDIA's bond yields surged the most in four months after the nation's central bank drained 2 trillion rupees ($27.4 billion) from the banking system at a higher-than-expected rate.

The cutoff for the 14-day reverse repurchase operation was set at 3.55 per cent, 20 basis points higher than the Reserve Bank of India's reverse repo rate of 3.35 per cent, and 3.5 per cent forecast by seven traders in a survey.

The central bank got bids worth 3.06 trillion rupees, it said. The cutoff fuelled investor concerns that the RBI was signalling higher rates. The yield on the 5.15 per cent 2025 bond was up 10 basis points to 5.33 per cent, taking its advance for the week to 23 basis points.

The benchmark 10-year bond rose 6 basis points to 5.95 per cent on Friday, the most since September 10. The RBI announced an open market bond purchase of 100 billion rupees for January 21 after market close.

"A combination of factors weighed on yields including higher cutoffs at the reverse repo, delay in RBI's open-market announcement and higher U.S. yields," said Vijay Sharma, executive vice president for fixed-income at PNB Gilts Ltd. Since the RBI has now announced the OMO, long-end yields are likely to go back into the last one-month's range, he said.

The RBI is draining excess cash after money-market rates crashed way below its 3.35 per cent-4.00 per cent interest-rate corridor late last year, spurring calls from investors to remedy a situation that could distort banks' asset pricing. Too sharp a rise could drive volatility and raise concerns that the central bank is withdrawing stimulus support.

"The reverse repo cutoffs are a clear sign that RBI wants to align money market yields above the operational policy rate, which is the reverse repo rate," said Arvind Chari, head of fixed income and alternatives at Quantum Advisors Pvt Ltd. "The cutoffs at the next two to three auctions will be crucial to see if this indeed is the start of normalization of monetary policy."

Short-term bonds sold off after the RBI's announcement last week to drain liquidity, as the market interpreted it as the start of a sooner-than-anticipated withdrawal of ultra-loose liquidity accommodation. Borrowing costs for Indian companies also surged, a fallout that the RBI would like to avoid amid a nascent growth recovery.

The RBI has since met with bank executives to assure them that easy policy will continue, according to people with knowledge of the matter. People's Bank of China, another Asian central bank, too withdrew cash from the financial system for the first time in six months on Friday.

The reverse repo auction alone may not be enough to support money-market rates given the high level of banking-system liquidity, according to ICICI Securities Primary Dealership Ltd.

The RBI may need to provide explain its liquidity normalization process, such as laying out steps and a time table for a reversal of its emergency policy accommodation, economists including A Prasanna at the dealership wrote in a note this week. (Bloomberg)